Home values on the move - beware of over-commitment on loans

IT'S been a big year for property with combined capital city dwelling prices rising by 7.9% over the 12 months to end October. It's great news for home owners but it's becoming a lot harder for first home buyers to get into the market.

The latest figures from researchers RP Data-Rismark show home values in Sydney have risen by 11.6% in the twelve months to end October. Melbourne is not far behind with home prices up 7.8% to the year ending October. Perth homes rose 6.9% and in Brisbane the rise was 3.4%.

At the other end of the scale, home values in Hobart dropped -0.7%, Darwin was down -0.1% while in Adelaide prices rose by just 1.9% over the same period.

Nationally, the median capital city home value is $511,000. The median for Sydney is much higher at $610,000.

It's always a challenge for first home buyers to save a decent deposit though this becomes a lot tougher when values are rising rapidly. Some first timers will find a solution by buying with a small deposit backed by lenders mortgage insurance (LMI).

LMI applies if your deposit is worth 20% or less of the property's value. In practice it involves paying a one-off premium - and the cost can be surprisingly high. As a guide, a first home buyer purchasing a $400,000 property with a 10% deposit of $40,000 could face an LMI premium of about $6,300. Buying the same property with a 5% deposit of $20,000 could see the cost of LMI reach around $12,600.

A number of lenders let first home buyers add the LMI premium onto their loan. The drawback here is that your monthly repayments will be higher, and it will also add to the long term interest cost.

An added sting in the tail is that LMI protects the lender if the home owner defaults on the loan. Borrowers receive no direct protection from LMI.

On the face of it, it's reasonable to think that paying LMI today can make better sense than saving a bigger deposit - by which time prices may have risen further. The trouble is, this overlooks a key issue of home ownership, and that's being able to live with your loan repayments even if rates were to rise in the future, and, at some point, they will.

I reckon there are two factors that should sound a warning bell for first home buyers hoping to purchase a home with a small deposit.

Firstly, Reserve Bank of Australia Governor Glenn Stevens recently commented on the lending growth in the housing market saying, "lenders and borrowers alike would be well advised to take due care." When the man who sets the official cash rate urges caution, I'd be inclined to listen.

In addition, a recent survey by broker group Mortgage Choice found more than half the first home owners who had purchased within the last two years are considered to be in mortgage stress. This means more than 30% of their after-tax income is going towards mortgage repayments.

The bottom line for first home buyers is that it is essential to think through your options very carefully. Yes, prices in many places are rising, however interest rates are at record lows and they won't stay that way forever. I'm a great believer in the value of home ownership - but not if it leaves you struggling with a mortgage you can't really afford.

Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.

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